Social Security "Lockbox" Just Puts Pols in a Box

President Bush finds himself in serious budgetary trouble. During the campaign, he solemnly promised that Social Security taxes would be spent on only one thing--Social Security. Now, even with optimistic economic forecasts and accounting gimmicks, recent budget projections show that he will have to tap the Social Security surplus to fund other programs throughout most of his first term. That's true even if popular tax breaks, such as the research-and-development tax credit, that are scheduled to expire are not renewed and even if not a penny is spent on developing a missile-defense system.

The Democrats, especially the majority who wisely voted against the President's tax plan, are understandably delighted at the prospect of attacking him for breaking his "read-my-lips" promise on Social Security in order to pay for tax breaks for the rich. Since Bush's multibillion-dollar tax package is responsible for the lion's share of the deterioration in the budget outlook over the next decade and is indeed strongly biased toward the wealthiest Americans, such attacks are as justifiable as they are politically enticing. Moreover, they are likely to resonate with voters, most of whom continue to rank Social Security above tax cuts in the nation's priorities. But what makes for an irresistible and timely political message contains some pitfalls that could come back to haunt the Democrats if the economy remains weak.

It is certainly true that both Social Security and Medicare face large unfunded liabilities when the baby-boom population begins to retire in about 10 years. It is equally true that using temporary Social Security surpluses to reduce the government's outstanding debt will make it easier to cover these liabilities as they become due. But it also is true that running a large federal surplus, whether on or off the Social Security budget, reduces aggregate demand and slows economic growth in the short run.

That's good economics when private investment and consumption are strong and the economy is booming. But it is flawed economics when the economy is faltering, as it is now. President Bush's economists--currently posing as converts to Keynesian economic logic--are right when they argue that this year's tax rebate is helping the economy, albeit modestly. A larger tax rebate would have been even better. But the Administration does not deserve the credit for sound fiscal policy. The rebate, which amounts to less than 2% of the total tax bill passed this year, was a Democratic initiative reluctantly accepted by President Bush to win passage of his tax cuts. Beyond this year's one-time rebate check, most Americans won't enjoy an additional time of tax relief from Bush's tax package. Moreover, the bulk of Bush's cuts, with an estimated price tag of over $2 trillion, will not take effect until after 2004, by which time the economy will have recovered, according to most economic forecasters. In fact, by worsening the long-term budgetary outlook, Bush's tax plan is keeping long-term interest rates stubbornly high and acting as a drag on growth.

Contrary to what Larry Lindsey, Bush's chief economic adviser argues, this is actually a fortuitous moment to repeal Bush's future tax cuts, especially the reduction in the top income-tax rate and the elimination of the estate tax that will benefit only the wealthiest 2% of taxpayers. Some of the savings from the repeal should then be used to fund a cut in payroll taxes for some kind of investment tax credit next year.

UNPREDICTABLE. It is also an ideal time to establish some kind of conditional budgetary mechanism that both addresses the long-term liabilities of Social Security and Medicare and responds to short-term changes in macroeconomic conditions. The economy's sudden about-face serves as a dramatic reminder that such changes can be both large and unpredictable, rendering budget projections obsolete before the ink in which they are written has begun to dry. Given the inherent uncertainty in economic and budgetary forecasts, Federal Reserve Chairman Alan Greenspan warned earlier this year that any long-term tax cut should be phased in and conditioned on the realization of long-term targets for the federal debt and for covering Social Security's liabilities. His warnings went unheeded.

Developing credible budgetary rules will not be easy. The aim: to achieve long-range targets for reducing the government's debt and funding its future liabilities, while simultaneously adjusting the timing of changes in spending and taxes to reflect actual macroeconomic conditions. It's time to try. In the absence of such rules, the nation's political leaders will continue to engage in annual budget battles that produce misguided policy outcomes and that confuse and alienate America's voters. Unfortunately, it looks as if the next annual budget spectacle--filled with misleading economic analysis and rancorous counter-charges--is about to begin. Let's hope the final outcome doesn't further weaken the American economy.

By Laura D'Andrea Tyson

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE